Understanding Permanent Establishment for Digital Nomad Business Owners
If you’re a digital nomad or freelancer with the freedom to work wherever you choose, you’ve probably thought about how your location affects your tax responsibilities. And if you haven't, you definitely should! If your business has an ongoing and stable presence in a country or state that is different to your home country, this could create a permanent establishment (PE) and you may be liable to pay taxes in that jurisdiction.
Although this sounds negative, it actually can be very beneficial!
For example, if you have incorporated a U.S. LLC, but you spend a lot of time working for the company from a co-working space in Portugal, you may have created a permanent establishment in Portugal, and could be required to pay Portuguese taxes.
Although this may initially sound daunting, a permanent establishment arrangement like this can actually be very beneficial tax-wise, since Portugal’s tax requirements are generally lower than in the US and double tax treaties mean that you won’t have to pay tax in the US too.
What Are Double Tax Treaties and How Do They Impact Permanent Establishments?
Double tax treaties (sometimes known as double taxation agreements or DTAs) are arrangements between two countries that stop you from being taxed twice on the same income. In general, if you are earning money while you are abroad and there is a double tax treaty in place between the country you are working in and your home country, you will pay tax in the country where you earn the money.
Here’s how double tax treaties can benefit your company if you have created a PE:
Taxation clarification: Double tax treaties help to define when a PE is deemed to exist in a foreign country, and clarify which jurisdiction will collect tax.
Avoidance of double taxation: DTAs provide mechanisms such as tax credits or exemptions to ensure that businesses are not taxed in both the country the money is earned in and the home country.
Determination of thresholds: Tax treaties establish thresholds such as duration of business activities or types of services provided, which determine whether a PE exists.
Legal framework: DTAs provide a legal framework for resolving disputes related to PEs between countries, ensuring fair and consistent application of tax laws.
Influence on business operations: Understanding these treaties helps businesses to structure their operations internationally, to minimise tax liabilities while ensuring compliance with local tax laws and relevant treaties.
Permanent Establishment for Digital Nomads
If you’re a digital nomad or freelancer who provides online services from abroad through a company, without your own dedicated office, permanent establishment can seem a little confusing at first.
However, it’s important to note that permanent establishment essentially refers to a significant presence in a foreign country, including a fixed location where you carry out your business activities.
This doesn’t mean that you need to have your own office – if you consistently work from your apartment or a co-working space and are responsible for the day-to-day running of your company, this could qualify as a permanent establishment.
Managing your business from a certain location is another way for digital nomads to set up permanent establishment, without the need to physically be there all the time.
What Defines a Permanent Establishment?
Although there is no clear definition of what constitutes a permanent establishment, many different factors are taken into account in a permanent establishment test. Here is a list of some of the criteria which are taken into account, and they are usually viewed as a collective when deeming whether a PE has been established:
Physical Presence: This is the most straightforward criteria, since having an office, factory or another fixed place of business in a foreign country is an easy way to demonstrate an ongoing and stable presence there.
Regularly working for your company from an apartment or co-working space can also count as evidence of physical presence.
Agent Dependence: If a person in the foreign country (other than an independent agent) habitually concludes contracts or plays a significant role in concluding contracts that are essential for the business, this may create a PE.
Location of Management: The location of management decisions can influence Permanent Establishment (PE) status. If key management and commercial decisions are made in a foreign country, this may contribute to establishing a PE there. This means that if you provide services from one country but make management decisions in another, or have a management team appointed to make decisions in another country, the PE is likely to be established in the country where the decisions are made.
Duration of Activities: The length of time that business activities are conducted in the foreign country is critical. Many tax jurisdictions specify thresholds (e.g., number of days within a year) after which a PE may be deemed to exist.
Services: Providing services in a foreign country through employees or other personnel for a specified period can trigger a PE.
Digital Economy: In the context of the digital economy, factors such as the existence of a website, server presence, and digital service provision may also influence the determination of a PE.
Construction or Installation Projects: A PE can arise from construction, installation, or assembly projects that exceed a specified duration in the foreign country.
Sales Activities: Significant sales activities, especially those conducted by a dependent agent, may lead to a PE.
Storage of Goods: Having a stock of goods or merchandise maintained in the foreign country for delivery or processing can also create a PE under certain conditions.
Advantages of Establishing a PE for Digital Nomads
Although setting up a permanent establishment can seem complicated at first and may be done unintentionally, for many digital nomads and global freelancers it can be a great way to maximise the benefits of your company’s foreign income and make tax savings, while remaining fully compliant.
Establishing a PE in a country that has favourable tax rates means that you could reduce your tax burden while living and working abroad.
According to FreshOps founder Michael Darby, “understanding the triggers of a permanent establishment can be a game-changer for business owners, particularly digital nomads and global freelancers who operate online. Pinpointing a tax-friendly jurisdiction and proactively shifting your PE can result in substantial savings."
In short, finding jurisdictions with lower tax rates and making proactive steps to create your business permanent establishment in that country, can really save you thousands!
Permanent Establishment Risk
Setting up a permanent establishment is a great option for many business owners who are remote workers. However, it’s worth noting that there are some risks associated with it – namely the risk of failing to pay the correct taxes.
However, by staying informed and consulting experts in taxation for digital nomads you can ensure that you remain fully compliant and fulfil your tax obligations.
Want to Learn More about How Setting Up a PE Could Benefit Your Business?
For many digital nomad, setting up a PE is the next step towards business success. But understanding what’s required to establish a PE and deciding which country suits your business best can be complicated.
Our network of lawyers and tax experts at FreshOps is here to help. Drop us an email at admin@fresh-ops.co.uk to find out more about how creating a permanent establishment could help you to develop your business, improve your financial health and remain compliant with overseas tax regulations.